ETF vs Mutual Fund
The manner in which investors are today putting their money in ETF suggests that this investing tool, which was once heralded as the new kid on the investment block, is today giving mutual funds a run for their money. There is a huge variety of both ETF’s and mutual funds in the market. In such a scenario, it is prudent to arm oneself with knowledge about all the features of these two investment instruments so that,one is aware of their differences on important economic parameters. This article will do just that, to help one understand differences between ETF and mutual funds.
We all know about mutual funds as they are a pool created with the resources of thousands of investors and this fund is managed as one portfolio. Any new purchases or sales from this portfolio add or subtract from the value of the portfolio. In the case of ETF, the shares issued to public merely reflect the value of the securities in the fund. These shares cannot be exchanged for cash but can be freely traded like shares and stocks between investors. There is no impact on the portfolio holdings as one cannot get cash for his shares. He can only sell them to another investor who desires to buy them. However, ETF’s generally pay higher index license fees than mutual funds.
ETF stands for Exchange Traded Funds and is similar to mutual funds as both investment instruments stitch together many securities to make up a diversified portfolio for the investor. However, mutual funds are traded at the end of the day in the markets and that too at their NAV (net asset value), whereas ETF’s are traded all day long just like stocks. Another difference pertains to operating expenses. ETF’s have lower operating expenses than mutual funds and there is no investment minimum or sales load which is conspicuous by its presence in the case of mutual funds.
ETF’s are said to have greater tax efficiency than mutual funds because of their structure that allows them to have very low capital gains. This makes ETF’s appear as more lucrative than mutual funds. ETF’s are loved by passive institutional investors because of their inherent flexibility. They can be purchased in whichever quantity suits the investor, and do not require any special documentation, special accounts, and margin or rollover costs. As far as active traders are concerned, they love ETF because they can be traded as easily as other shares and stocks.
Mutual funds have to carry cash to handle redemptions by owners of mutual funds. ETF’s do not need to maintain cash for this purpose and thus have no cash drag.
Despite these advantages that ETF’s enjoy over mutual funds, both ETF’s and mutual funds remain attractive investment options and one needs to make a fair assessment of his own requirements before making a financial decision as to which investment vehicle is better for him.